Keeping the engine running in the auto sector

The Detroit Motor Show coincides with a smattering of industry conferences to make January a busy month in the automotive sector – and a good source of intelligence for credit investors. Ilana Elbim, Credit Analyst, Hermes Investment Management, explains that the insights she gained from the conference floor at this year’s show reaffirmed convictions in a long-held relative-value trade involving two giants from the Motor City.

Sales forecasts: US to ease, China to brake

Most automakers currently agree on the outlook for 2019 on a regional basis. In the US, the market was strong last year with seasonally adjusted annual rate (SAAR) of sales registering at 17.2m[1] for 2018.

The expectation from car manufacturers and suppliers is that US SAAR in 2019 will remain healthy, but that further growth will be constrained as incentives have begun to decline, interest rates are rising and residual values are expected to fall.

However, in the world’s largest automotive market of China, the picture is a little worse. The current consensus comes after 2018 saw car sales decline in China for the first time in many years.

In 2019, automakers and parts suppliers anticipate that the first quarter will continue to see weakness that may stretch into the second quarter, although sales could stabilise in the second half of the year.

Meanwhile in Europe, last year was negatively affected by the implementation of the strict new Worldwide Harmonised Light Test Procedure (WLTP) at the start of September. The impact of WLTP is now behind us and car sales are expected to stay roughly flat this year.

Declining car sales were accompanied by other warning signs in Detroit. Most car manufacturers and suppliers mentioned trade tariffs, foreign-currency movements, rising commodity costs and an intense competitive environment as potential hazards. As a result, their guidance could be seen as conservative. Other companies including Ford, Goodyear and parts-maker Adient said they were unable to provide a view on their expected performance for 2019 – an unusual position to take at the Detroit show.

Driving seat: car ‘megatrends’

Consumers’ shift away from saloon or ‘sedan’ cars towards larger vehicles such as trucks and SUVs remains a theme. In Detroit, many companies announced large investments in the latter format. American Axle, a Detroit-based driveline and drivetrain specialist, said 70% of current production in North America was now skewed towards light trucks and that 70% of its backlog linked to that type of vehicle. Ford is allocating 90% of its resources towards these larger cars.

We also received new highlights about manufacturers’ electric and autonomous vehicle strategies at Detroit. Obstacles impeding the faster development of electric vehicles and impact profitability – such as battery costs, charging time, infrastructure and ranges – remain. However, electric-vehicle production should accelerate rapidly once technological advancements are made and regulatory pressure to reduce carbon emissions increases. China is likely to be among the biggest growth regions for electric vehicles.

When it comes to self-driving autonomous vehicles, timelines until commercial launch varied between the manufacturers and suppliers, ranging from late 2019 to the 2030s.

Car manufacturers were more open than usual to the possibility of forming partnerships to deliver these technologies, and GM recently said it remained open to finding another partner in addition to its work with Honda and Cruise Automation to develop an autonomous vehicle that can be manufactured at a high volume for global deployment[2]. Ford and Volkswagen announced a collaboration on electric and autonomous vehicles on the first day of the show.

GM: overtaking Ford

We continue to see GM as a better credit investment than Ford. The former has been more proactive than any of its peers on investing in megatrends that we believe will dominate in the future as sustainability prevails over existing ways of providing transportation.

GM’s CEO, Mary Barra, highlighted that the firm’s board of directors has always been very effective and supportive of its long-term sustainable strategy, allowing it to make the right investments at the right times.

In contrast, Ford’s management team publicly admits that it is behind on investing in electric and autonomous vehicles. Also, the business has been unable to provide additional details on the restructuring measures it announced in mid-2018, creating uncertainty among investors.

Ford’s credit metrics have subsequently weakened and the company is veering close to a downgrade to high-yield status. This appears to be already anticipated by the market as yields on Ford’s credit now trade close to the US BB Non-Financial High Yield index (see figure 1).

It should not come as news to our investors that we firmly believe that progressive and prudent manufacturers in electric and autonomous vehicles will benefit in the long term.

January’s information flow has reaffirmed this to us – and also that our preference of GM over Ford is an investment that fully reflects our convictions about the industry’s direction of travel. GM is making a genuine effort to prepare for the future, and is being rewarded with a lower credit-risk profile.

The above is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instrument.The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products.

[2] Comment made by GM CEO Mary Barra at the 2019 Global Auto Industry Conference on 16 January 2019.

Ilana Elbim

Credit Analyst

Ilana joined Hermes in November 2015 as a credit analyst covering the automotive, leisure, retail and consumer sectors. Prior to joining Hermes she spent three years as a credit analyst at Fitch Ratings, where she performed fundamental credit analysis on a portfolio of European investment grade and high yield issuers. Prior to this, Ilana had completed various internships as part of her Master’s degrees, including equity research at Natixis specialising in the luxury goods segment in 2012, and M&A research at KPMG in 2011. Ilana has a Master’s in Management, specialising in Corporate Finance, from the ESSCA Grande Ecole, France, and an Advanced Master’s in Finance from ESCP Grande École (ranked second in the world by the FT in 2016).